Option trading is the trading of derivatives that give you the right to buy or sell a particular instrument on particular date at a particular price.
An option is a deal that is related to that a particular security like a stock, bond, mutual fund etc. If you buy an option of any stock or share you, you can trade in that stock but you are not compelled to buy or sell the stock.
Let us understand with an example:
Surabhi is planning to buy a property of 50 lacs from Nikhil. There is a rumour that near the property the land price will increase as new multiplex is opening nearby in another 6 months which will increase the rate of the property to 60 lacs.
But what happens if the multiplex plan is dropped? The property price will fall to 45 lacs. Moreover, Nikhil place an option to Surabhi that she can buy the property for the same price which is called the STRIKE PRICE, only if she is willing to pay 2 lacs for a period of 6months.
Henceforth, Surabhi gets the liberty to buy or not to buy the flat within the mentioned period and Nikhil is under the deal with her that he has to give the first priority to Surabhi before selling to someone else.
The advance amount which Surabhi paid to Nikhil is called the PREMIUM in option trading. Option Trading can be done in stock, commodities, indexes and forex also.
Basic Option Trading Strategies.
Options helps you in buying good quantity of shares for a small amount of money called premium when compared to buying a share.
For example- if you buy a call option of Reliance share of strike price 1900 the lot size is 505 and the call money is Rs 72.50 so you have to pay only Rs 36,612.5
While if you will buy in cash then it will be 1900 X 505 shares which will cost you Rs 9,59,500.
Holders are people who buy call and put options. And Writer are those who sell call and put options.
Buying Call Option
Buying a call option means buying a lot of shares before the expiry date. The trader’s loss from long call is less risky to the premium paid.
The possible profit is much more, as the option payoff will increase. As the expiry is near and there is no limit to what high it can make. These are the following points while taking the trade:
- If the stock is in a “BULL” run then buying call option is at less risk.
- If you want to have the leverage then enter the trade to take advantage of rising prices.
Buying Put Option-
Buying a put option is equal to selling of shares before the expiry date ( last Thursday of a month). This is the opposite of call option. As the share price falls the put rate value increases with the fall. And when the expiry is near if the right strike price is chosen the rate of the Put increases.
- If the stock is in a “BEAR” run then buying put option is at minimum risk.
- If you want to have the leverage then enter the trade to take advantage of falling prices.
When the move is not certain and the indicators or price action is indicating the down move. Hence you can sell the call in less amount and the premium you get is very high.
It is similar to selling call but when the price is bouncing up from the support then only you sell the put.
How to do Option Trading?
Open a trading account and add funds:
As discussed in the previous articles, first open the account in the trading App .Then add the capital or funds in the app.
For trading in options, one should deposit Rs 1.5 lacs to Rs 2 lakhs which is the minimum quantity needed to trade in options.
Create Watchlist to trade:
First thing after adding funds is to do research about which stock has the most liquid options through NSE India website.
After that you have to create a watchlist where you can keep a watch at the option that you have find out after research.
Place an order to buy:
When you have figured the stock then according to the trend decide whether to buy a call or put option and which Strike price has the highest volume. Accordingly select the strike price and place the order.
Then check the margin whether you can place a trade or not and then decide the number of lots a trader want to buy.
You can also place the stop loss or target rate before entering the trade.
Exit the trade:
It is important to square off positions in options on either side whether at the stop loss or at the target. Do not be greedy for more profit. As the options decay very fast when near to monthly expiry which could make you bankrupt for the beginners.
Important Tips for Option Trading.
It is impossible for any trader to get profits in every trade. But to get profit in almost 8 out of 10 trades one should keep these points in mind:
- Keep the target price in mind always.
- Cut the losses in the first stop loss only. Don’t wait for the market to turn.
- Always select the most liquid stock and the highest volume strike price.
- Make a habit to exit with a profit of 2 to 5 percent for the beginners. Due to news effect the option moves very fast so it is better to take short profits than aiming for more.
- Divide the capital so that you can enter the two potential trades simultaneously.
Summary for Option Trading.
Through Option trading a trader can make numerous profits if done correctly. It can be a good source of income for many traders.
For good trading, an investor should be clear in their mind with their stop losses and target. A good trader is one who follows a strict discipline while trading.